WHAT IS 'Vanishing Premium Policy'

A vanishing premium policy is a form of permanent life insurance in which a consumer can use the dividends from such a policy to pay the premium. Over time, the cash value of the policy increases to the point where dividends earned by the policyholder equal the premium payment. At this point, the premium is said to disappear, or vanish.

BREAKING DOWN 'Vanishing Premium Policy'

Vanishing premium policies may be appropriate for consumers worried about longer-term fluctuations in income, such as the self-employed, people who wish to start a business or individuals who wish to retire early.

Some come with a high annual premium in the early years, at which time the policy offers modest benefits; the premium may subsequently drop, and the benefits then increase. Other policies may have a fairly steady premium and a set level of benefits until the vanishing point. In each case, cash value generally increases over time.

A vanishing premium policy may be suitable for some consumers who plan to use the policy benefits as supplemental income upon retirement. In the interim, the policy offers these policyholders tax-deferred advantages while cash value accumulates. In some instances, a person uses a vanishing premium policy in conjunction with estate planning.

One criticism of vanishing premium policies is that some insurance representatives who had sold these products in the past faced accusations that they misled consumers regarding the number of years for which they would have to pay premiums before the policy could support itself.

Consumers may also want to be careful not to rely mainly on the maximum benefit relative to minimum premiums, as the amount earned could fall below this scenario.

Lastly, it is important for prospective buyers to understand that the amount credited to cash value is lower when interest rates are lower than the expectation described in the policy; if this happens, policyholders may end up paying premiums for more years than they first thought. This also is why buying a vanishing premium policy during a period of historically high interest rates might be a bad idea.

A Brief History of the Vanishing Premium Policy

Vanishing premium policies got their start in the late 1970's and early 1980's, a period of very high nominal interest rates in the U.S. Many were sold as a form of whole life insurance. When dividend rates eventually declined, this increased the number of years many whole-life policyholders had to pay their premiums until the fees finally went away.

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